3.11 Why is investment volatile?

is there motivation for firms to smooth investment spending?

no, not really - they just do what they think will boost profits when it’s right for them - investment can be postponed unlike eating and drinking (consumption)

reasons why investment is volatile

(1) new technology - when new tech is introduced, one firm implementing it pushes other firms to invest leading to a large increase in investment

(2) credit constraints - in a buoyant economy, firms will borrow more but if there are credit constraints they won’t borrow as much or at all and investment will go down a lot

(3) coordination issues

vicious cycle

low demand for firm’s products —> low capacity utilization and low profits —> no incentive to invest or hire —> little spending by firms or workers —> low demand

virtuous cycle

if owners of companies decide to invest in new capacity and hire at the same time, they employ more workers woh spend more, increasing demand for the products of both firms, leading to porifts rising and a virtuous cycle

**basically, if everyone invested together, they’d all be better off

Figures 3.21 and 3.22 show that total investment spending can be volatile because the interaction of individual firms’ decisions can lead to vicious (low-profit) or virtuous (high-profit) circles. Which of the following might encourage all firms in the economy to behave in such a way that they all increase their investment spending together?

• 1.A major technological breakthrough in one industry (for example, in batteries for electric cars).

• 2.The end of a war abroad that was of sufficient importance to disrupt global trade.

• 3.The government asks firms to increase their investment.

• 4.An increase in government spending.

Select all that apply

2 and 4

**NOT 1 because it only affects one industry

**3 - this doesn’t actually give them an incentive

**4 - increases AD across the entire economy

**2 - afects entire economy, leads to increased confidence